Rating BUY

We suggest a BUY rating on Sinopec (NYSE:SNP). Although SNP experienced a decrease in net profit last year due to 2008’s record high crude oil prices, 2009 first quarter results marked a significant improvement in profitability. Net profit increased 85% as crude oil prices averaged around $45 per barrel in the 2009 first quarter, compared to over $100 per barrel in 2008. With lower crude oil prices and a new pricing mechanism which adjusts for the cost of crude oil, we expect another positive quarter from Sinopec (NYSE:SNP).

Lower oil prices, profitability increases

Despite the high international crude oil prices which increased SNP’s operating expenses, the government maintained a cap on domestic price of refined oil products. As a result, net operating profit fell by 47.3%. However, crude oil prices early this year were significantly below last year’s and SNP reported a profitable first quarter.

A new pricing mechanism

The implementation of the new pricing mechanism introduces a market-based ceiling price that is linked to the cost of crude oil, thus allowing companies to pass on high crude oil prices to consumers. We expect this reform to shield SNP from incurring large losses if the crude oil price increases significantly in the future.

Positive outlook, moderate valuation

High P/E ratio and positive profitability estimates suggests a favorable outlook for SNP in 2009. Net income for the year is forecasted to be 65,970 million, with an EPS of 0.75. We project a future growth rate of 20%.

 

SINOPEC Corporation

Key Income Statement Data	2005	2006	2007	2008
(RMB, millions)
Total Revenue	823,272	1,071,402	1,173,869	1,420,321
Total Operating Expenses	(764,441)	(992,582)	(1,123,842)	(1,474,320)
Operating Profit	68,246	83,820	85,864	28,123
Net Finance Costs	(4,625)	(6,100)	(8,101)	(3,776)
Profit Before Taxation	64,656	78,923	83,464	24,317
Tax Benefit/ (Expense)	(19,880)	(235,315)	(24,721)	1,883
Profit for the Year	44,776	55,408	58,743	26,200
Key Cash Flow Statement Data	2005	2006	2007	2008
Net Cash from Operating Activities	78,214	95,875	119,594	67,712
Net Cash used in Investing Activities	(77,523)	(103,023)	(113,587)	(110,158)
Net cash (used in)Financing Activities	(4,851)	1,192	(5,310)	41,777
Net Change in Cash and Cash Equivalents	(4,160)	(5,956)	697	(669)
Key Balance Sheet Data	2005	2006	2007	2008
Cash & Equivalents	5,014	2,763	7,969	6,948
Total Current Assets	81,257	83,788	185,116	164,311
Property, Plant & Equipment	170,711	270,783	375,142	403,265
Construction in progress	39,086	41,139	95,408	121,886
Total Assets	388,419	490,154	732,725	767,827
Total Current Liabilities	119,968	173,380	265,355	274,537
Long-Term Debt	53,401	52,689	83,134	90,254
Total Liabilities	215,112	271,851	399,967	418,505
Total Equity	173,307	218,303	332,758	349,322
Total Equity & Liabilities	388,419	490,154	732,725	767,827
Market Comparisons	Company	Industry	Sector	S&P 500
P/E Ratio (TTM)	17.84	7.22	68.56	95.07
Beta	1.65	0.96	0.45	0.99
Dividend Yield	3.35	1.86	0.42	2.61
Payout Ratio (TTM)	34.95	23.05	86.20	56.18
Sales (MRQ) vs Qtr. 1 Yr Ago	11.91	-30.83	12.86	-7.31
Sales (TTM) vs TTM 1 Yr. Ago	20.52	15.06	14.24	3.53
EPS (MRQ) vs Qtr 1 Yr. Ago	2.86	-108.79	-126.96	-38.01
Current Ratio (MRQ)	0.60	1.22	1.38	1.47
Total Debt to Equity (MRQ)	68.65	29.37	105.23	130.72
Asset Turnover (TTM)	1.94	1.31	0.82	0.83
Return On Assets (TTM)	3.49	9.97	3.44	6.98
Return On Equity (TTM)	9.36	17.74	8.76	21.14
Gross Margin (TTM)	5.52	36.61	20.95	39.06
Operating Margin (TTM)	1.94	12.84	5.49	-
Pre-Tax Margin (TTM)	1.67	12.30	4.58	11.60
Net Profit Margin (TTM)	1.80	7.56	2.78	8.08

 

Summary

China Petroleum & Chemical Corporation (Sinopec Corp) is an integrated energy and chemical company with principal businesses of exploration, production and trading of petroleum and natural gas, refining and sales of petroleum products and production and sales of chemical products. Sinopec has a competitive advantage as the largest petrochemical producer in China, with a leading arket position in the production and sales of refined oil products. Despite a fall in 2008’s profit margins, the company had a large increase in profitability in first quarter of 2009 as a result of lower crude oil prices. With the implementation of government reforms in the pricing of refined oil products in January 2009, we expect Sinopec to maintain reasonable profit margins even if crude oil prices escalate in the future. Sales growth and EPS in the most recent quarter remain higher than industry rates, signaling a positive outlook.

For complete report with charts, please click on pdf file: CV_SNP_H1_09.pdf

 

1. Lower oil prices, profitability increases

In 2008, Sinopec Corp experienced a decrease in net profit. Under its financial statements prepared in accordance to IFRS, Sinopec’s net profit attributable to equity shareholders of the company fell 47.3%, from 56,533 million (M) in 2007 to 29,769M in 2008. This is a marked change given that profit increased from 53,603M in 2006 to 56,533M in 2007. Consequently, earnings per share also dropped from 0.652 in 2007 to 0.343 in 2008.

This fall in profitability is primarily due to the increased crude oil prices in 2008 which caused operating expenses to increase by 31.2% over 2007. Crude oil prices peaked at $145 per barrel in July 2008.

Historical Crude Oil Prices (Monthly)

Purchasing expenses of crude oil constitute a significant component of SNP’s operating costs. As a result of the price hike, Sinopec’s purchasing expenses of crude oil and supplies increased by 32.4% in 2008, and accounted for 87.2% of the total operating costs. Yet, the government maintained a cap on the domestic price of refined oil products which caused a fall in net operating profit of 67.2% in 2008 and the company made an operating loss of 26,066M.

As demonstrated by the charts below, there is an inverse relationship between the company’s profits and oil prices. SNP has been more adversely affected by the oil prices than its competitors.

Sinopec Profit Margin vs Oil Price

 

Profit Margin vs Oil Price for SNP, PTR & CEO

Total revenue remained higher than its competitors due to the positive sales growth experienced by SNP in the last five years. Meanwhile, earnings per share have been on the rise since 2004, but declined in 2008.

Total Revenue for SNP, PTR & CEO

 

EPS for SNP, PTR, & CEO

However, net profit in 2009 Q1 increased 85% to 11,219M and earnings per share had risen from 0.070 to 0.129. Crude oil prices dropped significantly since 2008 from an average above $100 per barrel to an average of $45 per barrel in first quarter. While the drop in crude oil price reduced profits in the exploration and production segment by 76.1% when compared to 2008 Q1, the refining segment benefited from lower purchasing costs of crude oil, resulting in an operating profit of 7,328M.

Quarterly Net Profit for SNP

2. Oil price reform, a new pricing mechanism

Another factor that contributed to the increased profitability in 2009 Q1 was the establishment of the new pricing mechanism based on the “Notice on the Implementation of Price, Tax, and Fee Reforms for Refined Oil Products” promulgated by the State Council on December 18, 2008, and effective from January 1, 2009.

• Changes to the oil pricing regime

Prior to this reform, the government maintained a cap on the domestic price of refined oil products, which led to the fall in SNP’s net profit when crude oil prices rose above $100 per barrel during 2008. Under this new pricing mechanism, the government has introduced a market-based ceiling price that is linked to the price of crude oil.

According to the China’s National Development and Reform Commission (NDRC), domestic fuel prices will be adjusted once there is a greater than 4 percent move of global crude oil prices from their moving average over 22 working days.

• Impact on profitability

Previously, as at April 2008, $68 was approximately the point at which cost equals revenue for most Chinese oil companies, above which they would face a loss, while Sinopec could afford a crude oil price of about $ 76 per barrel.

With the new price mechanism, profits should be “normal” even when the crude oil price increases to $80 a barrel, with lower margins once the price rises above $80. According to NDRC, if the crude oil price rises above $130, the fuel price is unlikely to increase any further, or only by a small amount, but oil supplies will be maintained through the use of fiscal and tax mechanisms.

We expect this new pricing mechanism to shield Sinopec from incurring large losses if the oil price increases significantly in the future, as it allows the fuel price to reflect the global crude oil price. There still remains some uncertainty regarding this regime given the lack of crucial details on how it would operate. Nevertheless, it marks an improvement in the flexibility of domestic oil prices.

Sinopec is likely to benefit from this reform more than its competitors (PTR and CEO) as it supplies 80% of China’s fuel. The company also imports over 70 percent of its crude oil used in their refining segment, while Petrochina and CNOOC derive their profits mainly from oil exploration and production.

3. Profitability Analysis

SNP PTR INDUSTRY Sales (MRQ) vs Qtr 1 Yr. Ago 11.91 -30.01 -30.83 Sales- 5 Yr Growth Rate 26.46 28.11 24.60 EPS (MRQ) vs QTR 1 Yr Ago 2.86 -37.5 -108.79 EPS- 5 Yr Growth Rate -0.11 7.76 17.32 Gross Margin (TTM) 5.52 37.23 36.61 Gross Margin - 5 Yr Avg 13.25 48.81 33 Operating Margin (TTM) 1.94 14.51 12.84 Operating Margin- 5 Yr Avg. 6.32 25.42 15.44 Net Profit Margin (TTM) 1.8 11.28 7.56 Net Profit Margin – 5 Yr Avg. 4.39 19.13 9.82 Return on Assets (TTM) 3.49 9.97 Return on Assets - 5 Yr Avg. 7.65 16.08 13.15 Return on Investment (TTM) 5.73 12.84 Return on Investment- 5 Yr Avg. 12.42 21.09 17.09 Return on Equity (TTM) 9.36 17.74 Return on Equity – 5 Yr Avg 17.85 22.73 23.67 Quick Ratio (MRQ) 0.25 0.68 0.93 Current Ratio (MRQ) 0.6 0.99 1.22 LT Debt to Equity (MRQ) 38.68 6.56 18.96 Total Debt to Equity (MRQ) 68.65 37.84 29.37

Sinopec has achieved remarkable sales growth of 11.91% in first quarter 2009 against the industry’s negative growth of 30.8%. Meanwhile, its competitor PTR experienced negative growth of 30.0%.

Despite high sales, profitability ratios for 2008 were lower than SNP’s 5 year average, and relatively low in comparison to PTR and the industry. In particular, the gross margin suffered due to the high purchasing costs of crude oil in 2008. While PTR and industry gross margins were 37.23 and 36.61 respectively, SNP had a gross margin on 5.52. Consequently, the operating margin of 1.94 and net profit margin of 1.8 in 2008 were considerably lower than industry rates.

In terms of financial strength, SNP was more highly leveraged than PTR and the industry average in 2009 Q1. Total debt to equity ratio and long term debt to equity ratio was 68.65 and 38.68, while the industry average was 29.37 and 18.96. Also, the quick ratio was a low 0.25 compared to the industry quick ratio of 0.93.

4. Moderate valuation, positive outlook

2004 2005 2006 2007 2008 2009 E Net profit for period 41,791 44,776 55,408 58,743 26,200 62,609 EPS 0.42 0.48 0.62 0.65 0.34 0.72 EPS change 14% 29% 5% -48% 112% Dividend payable 10,404 11,271 13,005 14,306 10,404 17,463 Dividend/Share 0.12 0.13 0.15 0.16 0.12 0.20

Profitability estimates for 2009 and the upcoming quarter are promising. The 2009 net profit is estimated to be 62,609M which would be a significant improvement from 2008. EPS is estimated to rise from 0.34 in 2008 to 0.72 in 2009, representing an increase of 112%.

Total dividend payable is estimated to be 187,463M in 2009, compared to 10,404M in 2008. Thus dividend per share is expected to increase from 0.12 to 0.20.

For the upcoming quarter, net profit is estimated at 13,498.20M, representing a 20% net profit growth rate for the future. SNP’s P/E ratio of 16.42 is high in comparison with PTR’s P/E ratio of 13.42, and the industry ratio of 5.31. However, with the current P/E of 16.42 and a projected EPS growth rate of 21%, SNP’s Price/Earnings to Growth Ratio is 0.78. A PEG ratio below 1 suggests that SNP’s stock price is moderately valued and we recommend a buy rating.

2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2 E Net profit attributable to equity shareholders 6,062.00 2,193.00 8,168.00 13,346.00 11,219.00 13,498.20 EPS 0.07 0.03 0.09 0.15 0.13 0.16 Net profit growth rate -10% -64% 272% 63% -16% 20% EPS growth rate -8% -64% 276% 61% -15% 21%

 

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Table 1: Sinopec Corporation - Annual Income Statement, 2006-2009 (RMB, millions)

 

 

Year to December 2005A 2006A 2007A 2008A Turnover and other operating revenues Turnover 799,259 1,044,652 1,173,869 1,420,321 Other operating revenues 24,013 26,750 30,974 31,780 823,272 1,071,402 1,204,843 1,452,101 Other income 9,415 5,000 4,863 50,342 Operating expenses Purchased crude oil, operating supplies (651,201) (861,437) (970,929) (1,285,155) Selling, general and administrative expenses (33,880) (37,758) (37,843) (46,175) Depreciation, depletion and amoritsation (31,618) (34,235) (43,315) (45,832) Exploration expenses (6,411) (7,983) (11,105) (8,310) Personnel expenses (18,649) (19,857) (22,745) (23,285) Taxes other than income tax (17,185) (28,639) (34,304) (56,799) Other operating expenses (5,128) (2,437) (3,601) (8,773) Total operating expenses (764,441) (992,582) (1,123,842) (1,474,320) Operating profit 68,246 83,820 85,864 28,123 Finance costs Interest expense (5,926) (7,437) (7,314) (11,326) Interest Income 384 555 405 445 Unrealised gain/*loss) on convertible bonds - (3,211) 3,947 Foreign currency exchange losses (79) (153) (311) (954) Foreign currency exchange gains 996 935 2,330 3,112 Net finance costs (4,625) (6,100) (8,101) (3,776) Investment income 178 256 1,657 390 Share of profits less losses from associates 857 947 4,044 580 Profits before taxation 64,656 78,923 83,464 24,317 Tax benefit/(expense) (19,880) (235,315) (24,721) 1,883 Profit for the year 44,776 55,408 58,743 26,200 Attributable to: Equity shareholders of the Company 41,455 53,912 56,533 26,796 Minorty Interests 3,321 1,496 2,210 1,883 Dividends payable to equity shareholders Interim dividend declared during the year 3,468 3,468 4,335 2,601 Final dividend proposed 7,803 9,537 9,971 7,803 11,271 13,005 14,306 10,404 Earnings per share: Basic 0.48 0.62 0.65 0.34 Diluted 0.48 0.62 0.65 0.30

 

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Table 2: Sinopec Corporation - Annual Balance Sheet, 2006-2009 (RMB, millions)

 

 

Year to December 2005 2006 2007 2008 ASSETS Non-current assets Property, plant and equipment, net 170,711 270,783 375,142 403,265 Construction in progress 39,086 41,139 95,408 121,886 Interest in associates 5,933 7,470 16,865 15,595 Interest in jointly controlled entities 7,280 7,482 12,723 11,781 Investments 1,037 971 3,194 1,483 Deferred tax assets 3,220 5,936 10,439 12,810 Lease prepayments 568 765 8,224 10,817 Long-term prepayments and other assets 3,748 5,011 10,124 11,642 Total non-current assets 307,162 406,366 547,609 603,516 Current assets Cash and cash equivalents 5,014 2,763 7,969 6,948 Time deposits with financial institutions 110 220 668 752 Trade accounts receivable, net 8,826 8,832 22,947 12,989 Bills receivable 1,334 2,760 12,851 3,659 Inventories 50,417 53,988 116,032 95,255 Prepaid expenses and other current assets 15,556 15,225 24,922 34,925 Income tax receivable - - - 9,784 Total current assets 81,257 83,788 185,116 164,311 Total assets 388,419 490,154 732,725 767,827 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Short-term debts 25,059 38,241 44,654 74,896 Loans from Sinopec Group Company 3,946 1,358 15,840 23,587 Trade accounts payable 28,833 38,041 93,049 56,667 Bills payable 19,077 16,265 12,162 17,493 Accrued expenses and other payables 40,559 72,313 89,171 101,878 Income tax payable 2,494 7,162 10,479 16 Total current liabilities 119,968 173,380 265,355 274,537 Non-current liabilities Long-term debts 53,401 52,689 83,134 90,254 Loans from Sinopec Group Company 39,212 38,840 37,180 36,890 Deferred tax liabilities 2,216 6,174 5,636 5,235 Other liabilities 315 768 8,662 11,589 Total non-current liabilities 95,144 98,471 134,612 143,968 Total liabilities 215,112 271,851 399,967 418,505 Equity Share capital 86,702 86,702 86,702 86,702 Reserves 86,605 131,601 220,731 241,967 Total equity 173,307 218,303 332,758 349,322 Total liabilities & shareholders' equity 388,419 490,154 732,725 767,827

 

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Table 3: Sinopec Corporation - Annual Cash Flow Statement, 2006-2009 (RMB, millions)

 

 

Year to December 2005 2006 2007 2008 Net cash generated from operating activities 78,214 95,875 119,594 67,712 Investing activities Capital expenditure (63,993) (70,604) (99,946) (99,636) Exploratory wells expenditure (5,810) (7,985) (9,913) (8,380) Purchase of Investments and investments in associates (3,650) (3,571) (1,581) (3,089) Proceeds from disposal of investments 1,264 717 1,441 1,366 Proceeds from disposal of property, plant and equipment 567 406 413 263 Acquisitions of non-controlling interests of subsidiaries (4,324) (21,971) 0 (598) Purchase of time deposits with financial institutions (565) (916) (3,373) (1,442) Proceeds from maturity of time deposits 1,462 1,283 3,340 1,358 Net cash used in investing activities (77,523) (103,023) (113,587) (110,158) Financing activities Proceeds of issuance of corporate bonds 9,875 22,689 35,000 15,000 Proceeds from bank and other loans 554,187 764,659 768,039 1,147,279 Repayments of corporate bonds 0 (21,000) (12,000) (10,000) Repayments of bank and other loans (557,692) (754,159) (788,793) (1,125,333) Distributions to minority interests (1,682) (852) (593) (1,404) Contributions from minority interests 129 1,255 1,223 1,137 Dividend paid (10,404) (11,271) (13,872) (12,572) Distributions to Sinopec Group Company (3,218) (216) (5,682) (2,180) Net cash generated from/(used in) financing activities (4,851) 1,192 (5,310) 41,777 Net (decrease)/increase in cash and cash equivalents (4,160) (5,956) 697 (669) Cash and cash equivalents at 1 January 18,251 14,069 7,063 7,969 Effect of foreign currency exchange rate changes (22) (25) (64) (79) Cash and cash equivalents at 31 December 14,069 8,088 7,696 6,948

 

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Analyst Certification

 

 

I, Linette Ng, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report.

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For complete report with charts, please click on pdf file: CV_SNP_H1_09.pdf